Margin Debt the Size of Microsoft Is No Big Liability for Stocks

  • Record speculative buying often seen as sign of euphoria
  • Yet current pace in equity credit growth is nowhere near 2000

Margin debt just shot to another record in the stock market.

About $530 billion was extended as credit by brokerages to clients at the end of February, up 2.9 percent from the previous month, according to data released Wednesday by the New York Stock Exchange. The amount, approaching the market value of Microsoft Corp., is the most since 1959.

While reports of surging margin debt are forever deployed by bears as evidence enthusiasm for stocks is overheating, the view doesn’t hold a lot of water, said Michael Shaoul, chief executive officer of Marketfield Asset Management. While the value of stock loans usually tops out at the same time as the S&P 500 Index, the idea that the first predicts the second is an optical illusion.

“It is fair to say that the recent buildup is not in itself problematic or evidence of a substantive change in usage of leverage,” Shaoul wrote in a note to clients. “Long bull markets such as this one tend to see margin expand steadily recording many all-time highs along the way. Only in the latter portions explode in a manner that issues a worrying signal.”

Margin debt, compiled monthly by the NYSE, is money clients borrow from brokerages to purchase shares. It hews closely to benchmark indexes such as the S&P 500 Index, probably due to the role of equity in backing the loans.

In the 12 months through February, margin debt increased 18 percent, in line with the 20 percent gain in the S&P 500. During comparable periods leading up to the previous two bull market peaks, margin debt growth outpaced share gains by threefold in 2007 and almost five times in 2000.

The interest rate charged when brokers borrow from banks to cover client positions is rising. The rate, also known as broker call, has risen to 2.75 percent from 2 percent at the end of 2015.

Does the rising cost of debt service signal a reversal in the trend of margin debt? Shaoul doesn’t think so. The increase reflected the three rate hikes by the Federal Reserve and at the current level, the cost is only slightly higher than the 1.97 percent yield that the S&P 500 companies offer as dividends.

“We would not take this rise to be a signal of an imminent top, although it is a reminder that cash is not entirely ‘trash’ in the current environment, a subtle but important change to the overall investment landscape,” Shaoul said.

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